Head of Commodity Strategy
Summary: Following a period of relative calm, the agriculture sector has embarked on another upside extension with the Bloomberg Agriculture index rising to a fresh 3-1/2-year high. Weather worries in South America supporting soybeans and sugar while emerging tightness in key crops are driving increased speculative interest. Adding to this the prospect for increased mobility lifting the outlook for softs like cocoa, coffee and cotton.
Following a period of relative calm, the agriculture sector has embarked on another upside extension. During the past week the Bloomberg Agriculture Index has gained 3.7% to reach a fresh 3-1/2-year high. As per the table below we are now seeing strength from both cocoa and coffee, a corner of the market that has suffered during the pandemic with consumers being stuck in their homes instead of visiting bars, restaurants and travelling through airports.
Cotton, another soft commodity has raced higher as demand for fibers look set to rise as consumers return to the shopping malls. At 95 cents/lb it is near the double top from 2014 and 2018 around 97 cents, just ahead of the 100 cents/lb mark not touched since 2011.
Other developments that have caught the markets attention are ongoing weather problems in South America. Poor weather in Brazil is currently supporting the prices of soybeans, sugar and coffee. Heavy rains during the past week have delayed the harvest of soybeans while exacerbating shipping logjams which are also impacting the export flows of sugar.
Increased edible oil demand is currently very strong with the May soyoil contract in Chicago soaring to 50.8 cents/lb, the highest level in eight years. Dryness in Argentina, a top exporter of processed bean products, has been one of the recent catalysts at a time of increased demand for edible oils together with a recovery in demand for biodiesel.
Arabica coffee, mostly produced in Brazil, has risen to a 14-month high with adverse weather - drought during flowering followed by too much rain – driving the price higher at a time where the market is beginning to look for a post-pandemic pickup in demand. Rabobank’s respected softs analyst has raised his global coffee-deficit forecast for 2021-22 to 2.6 million bags, compared with a surplus of than 10 million bags the previous year.
Adding to the list of supporting factors we have the recent cold spell, both in Russia, Europe and most noticeable in the U.S. which has raised concerns about a reduced winter wheat crop due to winterkill phenomenon. Staying with the grains sector, last week the chief economist at the US Department of Agriculture told the annual Outlook Forum that grains and oilseed prices, despite record planting, will remain tight during the 2021-22 season. The tightest beginning stocks for corn, soybeans, and wheat in several years, and expectations of continued strong import demand from China will continue to underpin prices. Unless production surprises to the upside and China slows its rapid purchase programs.
The emerging tightness across key agriculture commodities has resulted in the average roll yield of holding a portfolio of 11 ag futures for one year, has risen to the highest level in at least a decade. Since 2014 and up until last year, the constant state of oversupply, helped create a market where spot prices were the cheapest on the curve. With spot prices now being bid up we have seen a return to backwardation. This development where the front month contracts trade higher than the next helps create a positive carry when rolling the expiring contract into a later dated contract at a lower price.
By now the self-feeding loop is on full display: Strong fundamentals raising the roll yield while boosting the price thereby creating strong upside momentum which attracts even more buying, not only across agriculture commodities, but also other sectors such as energy and industrial metals.
In the week to February 16 hedge funds and other large speculators lifted bullish bets on 13 U.S. traded agriculture futures to a record 1.25 million lots, representing a nominal value of 45 billion dollars. The biggest exposure being held in CBOT corn (28%) followed by 26% in the three soy complex contracts of beans, meal and oil. In third place at 15% we have sugar while the smallest exposure is currently found in cocoa and feeder cattle.
The latest increase represents the culmination of a buying spree which started last June, as inflation worries due to massive amount of stimulus helped boost interest in commodities, with agriculture gaining extra interest due to production setbacks and rising demand for corn and soybeans from China.
Examples of Exchange Traded Funds/Commodities which tracks the agriculture sector.
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As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
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